Fed Cuts Rate Half Point, And Stock Markets Soar

By EDMUND L. ANDREWS

Published: September 19, 2007

The Federal Reserve rolled out its most powerful interest rate weapon on Tuesday in a bid to stop the turmoil in housing and financial markets from bringing down the overall economy.

But even as stock markets soared in a thunderous rally, the Fed carefully stopped short of implying any commitment to reduce rates even more in the months ahead. Indeed, policy makers cautioned that they still have lingering worries about inflation -- a concern that would weigh against stimulating the economy further with cheaper money.

In reducing its benchmark interest rate by an unusually large one-half percentage point, to 4.75 percent from 5.25 percent, the central bank made it clear that policy makers viewed the turbulence and disruptions of the past couple of months as too dangerous to ignore.

The reaction in stock markets was ecstatic: the Dow Jones industrial average jumped 200 points almost instantly and ended the day up 335 points, or 2.51 percent, at 13,739.39.

The move was the Fed's first rate reduction of any kind in four years, the steepest in nearly five years and its most abrupt reversal of course since January 2001, when policy makers sharply cut rates at an unscheduled emergency meeting just before the last recession.

''Shock therapy,'' summed up Ethan Harris, chief United States economist at Lehman Brothers.

For consumers, the Fed's move could mean lower borrowing costs for mortgages and automobile loans. But the impact may be muted, because investors remain deeply anxious about the credit quality of mortgages and other long-term loans. The main problem in the last month has not been high rates so much as the availability of capital to complete deals.

Analysts described the Fed's action as a bold attempt to restore confidence, with a quieter caveat that investors and consumers should not assume the certainty of more painkillers later this year.

''The important policy debate now centers on the future interest rate path, but Fed officials left that more ambiguous,'' said Richard Berner, chief United States economist at Morgan Stanley.

Indeed, while many on Wall Street have been clamoring for an aggressive rate cut, some economists had warned against it, saying that it might send the wrong signal by bailing out those who contributed to the housing bubble and encourage future market excesses.

In both the bold stroke and the fine print, the Fed's move offered a revealing hint about Ben. S. Bernanke, the former professor from Princeton who took over as Fed chairman last year.

Mr. Bernanke, a champion of steady rules to guide monetary policy, has long been seen as more skeptical about reacting to financial turbulence than his predecessor, Alan Greenspan.

Mr. Bernanke, for example, made it clear that he did not want to rescue investors or real estate speculators who made bad decisions. But in shielding the economy from a downturn, the Fed will inevitably be helping some of the very people Mr. Bernanke did not want to help.

What seems to have driven Mr. Bernanke to act more boldly, analysts said, was the jolt from the Labor Department's unexpectedly poor employment report for August, which showed that the nation had lost jobs for the first time in four years.

Still, Mr. Bernanke's move was nothing if not a Greenspanian display of ''discretionary'' policy in response to trouble but before the signs of an economic downturn were unambiguous. And in doing so, he obtained unanimous agreement from other board members, even though some Fed officials have been dubious about the need for a rescue.

The Fed's course change has been under way since early August, when fears about huge losses on subprime mortgage loans and a continued downturn in housing caused a much broader panic in credit markets.

The resulting credit tightness has now affected all but the safest home mortgages and has also greatly reduced the ability of private equity funds and hedge funds to borrow money at low rates. Many banks, which had been planning to resell their loans into the giant market for tradable commercial debt securities, are now being forced to absorb loans that the securities markets will no longer take.

In the rate cut and an accompanying statement, the central bank acknowledged that the risks of a recession were too big to ignore.

''The tightening of credit conditions has the potential to intensify the housing correction and restrain economic growth more generally,'' the Fed's policy-making committee said in its statement. ''Today's action is intended to forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets.''

Leaving the door open for the possibility of additional rate cuts, the central bank said it would ''continue to assess'' the economic outlook and ''act as needed to foster price stability and sustainable economic growth.''

But while Fed policy makers abandoned previous statements that the risk of inflation was their ''predominant concern,'' they did not say that the risk of a downturn had replaced inflation as their main worry. Rather, they spoke of ''uncertainty'' and left it at that.